You just can’t keep a bad idea down. The New York Times, reporting on Europe’s economic angst here and here, wallows in money illusion. Let’s survey the scene of the crime and speculate on the motives.
The way I teach it in introductory macro, there are two types of money illusion. In Type I you are aware of wage increases but not price increases; you think you have more purchasing power than you really do. In Type II you are aware of price increases but not wage increases; you think that if only prices would stop going up you would have more purchasing power than you do. Both are fallacies, since wages are prices, or to put it differently, the money you spend for the things you buy all ends up as someone’s income. It is a logical impossibility for Europeans as a whole to suffer loss of real income as a result of inflation. (And, just to provide context, recall that the rate of price increases over there is in the 3-4% range, not good but certainly sub-ferocious.)
So what are the real problems? The biggest one is income distribution, which is becoming more unequal across the continent as moderating institutions are eroded under the pressure of global competitiveness. This has the most immediate effect on workers who produce goods and services for export or which compete with imports, and it spills over into other labor markets as the wages of the most vulnerable workers slip backward. Firms are also adjusting their organizational strategies to the new world of global competition, relying progressively less on long-term relationships with employees shielded from market forces.
Another possibility, hinted at in these articles, is an adverse shift in the terms of trade, as oil and gas imports become more expensive relative to manufactured exports. Food is less clear, however, since Europe exports vigorously (and controversially) in agricultural products, which leads one to wonder where are the farmers, and those who sell to them, in these tales of Euro-woe.
By blaming the deterioration in living standards on the wrong culprit, these stories detract attention from the true causes. The ECB can crank its rates as high as it wants in order to snuff out inflation, but this won’t restore real income to the average European—quite the contrary, actually, since high rates will produce more unemployment while further elevating the already too-high euro. Wrong diagnosis, wrong treatment.
The question that comes to my mind is why this nonsense about inflation lowering real incomes still has traction after all these years. The disproof is no more complex than the old, familiar circular flow diagram. My suspicion is that it can be attributed to the fundamental political economy fact about inflation: that unanticipated increases in inflation reduce the wealth of net creditors, who map more or less perfectly on the rich as a whole. There will always be a need to find a reason to make inflation the scapegoat for whatever ails the general public, and simple logical error will not constitute a disqualification.